Energy price caps: necessary but not sustainable

4 min read 26 Sep 22

The “Energy Price Guarantee” policy, announced by the new UK government, freezes the Ofgem utility price cap for households at £2,500 from 1st October for the next two years at an estimated cost of around £150bn in total (i.e. roughly £75bn per year or 3% of GDP).

The direct economic impact is UK household energy bills will be lower than previously forecasted resulting in higher disposable incomes. The downside of the policy is the lack of targeting based on income means a significant deadweight loss to the public finances where money will be used to reduce the price of energy for better-off households.

The advantage of capping the price of energy is it ensures that support is provided in a timely way, and the amount of support received is in line with a household’s energy need. A broad policy such as a price cap will provide support to households across the income scale rather than ‘cliff-edge’ support based on who is and isn’t eligible. The policy also links support to need and therefore taking into account household size rather than policies to date which have been based on fixed transfers per household.

The downside of a universal price adjustment is the lack of targeting towards lower income families. This will result in significant spend for those on higher incomes as well as eliminating the incentive for higher-income households to reduce energy use. The announced policy will provide broad support and now - reflective of the scale of the energy problem and the need to act fast.

However a policy of funding a price cap is a short-term solution, wholly reliant on high energy prices proving to be short-lived. This is contrary to market expectations where wholesale futures markets are pricing high energy prices for some time1. The most meaningful solution beyond the near-term is to scale up renewable and nuclear energy generation and reform the power market to de-link the price of gas from other forms.

Another option that hasn’t been considered in the UK but is central to the solution explored by European countries is to reduce demand by increasing efficiency. EU members have agreed to reduce gas consumption by 15% between August 2022 and March 2023². The median energy efficiency score for properties in England is equivalent to a band D³ (rated on a scale A-G). Prior to the announced price cap, the Resolution Foundation, a think-tank, estimate that this winter households in the least efficient properties (EPC F) will face monthly energy bills £231 higher than an equivalent C-rated home⁴. This underscores both the poor energy efficiency of property stock in the UK and the cost savings associated with improving efficiency.

Paying a proportion of energy bills for households and business will lead to a larger budget deficit and higher debt. Financial markets have been adjusting to the combination of looser fiscal policy in recent days by selling UK government bonds. Borrowing to cover energy consumption costs is not a sustainable solution – equally the price rises households are facing are too large not to provide assistance. Combining immediate assistance via a price cap while at the same time considering solutions such as increasing renewables roll-out, reforming the power market and improving building efficiency are more sustainable solutions and would maximise the success of the Energy Price Guarantee.

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